Liquor Stocks Are Outrageously Overvalued

In my mind, liquor stocks should be almost as much of a slam dunk as tobacco companies such as Philip Morris International (NYSE:PM). As it turns out, I’m wrong.

That’s because tobacco is an addictive product that is easily accessible and, despite escalating prices from taxation, still relatively inexpensive. Spirits aren’t quite the same. They’re only addictive if used in regular excess, and they’re more of a recreational product. If anything, the their performance is more linked to people’s level of discretionary income. The question is whether any of these companies have stock that’s worth buying.

Constellation Brands (NYSE:STZ) handles the lower end of the wine business, with labels like Mondavi and Blackstone and spirits like SVEDKA Vodka and Corona beer. Spirit companies often have strong cash flow, and Constellation did $810 million of FCF in the TTM. There’s not a lot of cash on hand, but its $2.5 billion in debt (plus an additional $600 million in a new bond offering) is easily covered by operational cash flow.

It also has terrific margins at 16%. However, earnings are expected to fall 13% this fiscal year before rebounding 20% next year.  The problem with Constellation, then, is its valuation. At 9% long-term growth, the stock trades at an almost 15% premium to its current price. It’s not outrageously overvalued, though, so if it dips, it might be worth grabbing.

Diageo (NYSE:DEO) is loaded with brand names: Johnnie Walker, Bailey’s, Captain Morgan, Ketel One, Tanqueray, Guinness and Seagrams, among many others. The company’s free cash flow has been historically terrific, running $2 billion to $3 billion annually, of which about half is paid out in dividends (2.2% yield currently).

The more upscale brands dovetail nicely with the increased spending we’ve been seeing by more well-to-do folks in the past couple of years. That’s why earnings are set to grow 20% this year, 11% next year and 11% annually over the next five years.

In this case, however, Diageo also displays the same problem I am constantly encountering across just about every sector: The stock is vastly overpriced. Even attaching a 15x multiple to this year’s earnings of $5.95 (which includes the 2.2% yield and a premium for great cash flow), the fair value is $79, but the stock is at $96. Sheesh.

What about that old standby, the parent company of Budweiser, Anheuser-Bush InBev (NYSE:BUD)?  The beer and its peer brands certainly have broad appeal, and that’s why the company continues to grow at a solid 10% clip year after year.

Free cash flow is even more impressive — $7.6 billion in 2010, for example. Once again, however, the stock feels vastly overpriced: 8.6% projected long-term annual growth, plus 1.9% yield gives a 10.5x multiple. Make it 12.5x for the great cash flow and on FY12 earnings of $4.55, fair value is about $57. The stock is at $71. Double sheesh.

So pass me the booze. I love spirit companies, but I’m not loving the stocks right now. But on a major market pullback, they may have a place in the stalwart section of your portfolio.

As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities.

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